Donald Trump dampens US - Chinese relations

Donald Trump’s protocol-breaking phone call with Taiwan’s president is just the first salvo in a looming trade war between the US and China that will hurt both countries, says Bill Powell

EARLY one evening in January, 2009, Xiao Hongzhi walked down a deserted street in the eastern Chinese city of Dongguan, to the door of the factory at which he had until recently worked.

It was shuttered, and a note on the gate told former workers that they should go to the local party office, where they would receive compensation.

Xiao shrugged, and headed off, relieved that he’d get some money.

Dongguan, in the coastal province of Guangdong, was arguably the epicentre of what Western economists now call the ‘China Shock’: The massive impact, for good and for ill, of Beijing’s emergence as the world’s factory floor.

In the years since China’s economic opening to the world, it became home to factories that made everything imaginable, and it exported those goods to the rest of the developed world.

That is why Dongguan was in turmoil when I visited in 2009, and why Xiao no longer had a job. A financial crisis in the United States, half a world away, had laid waste to the world’s largest economy, and that meant that export-dependent China — and Dongguan in particular — was in trouble.

In fact, Xiao was one of the lucky ones — he and his small family got compensation, with which they financed their trip back to their home province in central China, where he now runs a small business.

Earlier that same day, when he and I had visited the closed factory, hundreds of riot police had been summoned to break up a demonstration by workers at another factory, whose owner had shuttered it and left town, leaving nothing.

Ugly incidents like that panicked the Chinese government. To placate those millions of workers whose lives were upended by what had happened on Wall Street, China went on a debt-fuelled spending binge, which is still driving its economy.

No matter: The Chinese Communist Party knew that if all those workers weren’t mollified, China’s rulers might have been looking into an open grave.

During more than a decade of living and reporting in China, nothing better illustrated for me the extraordinary impact the two economies, American and Chinese, have on each other than my trip to Dongguan.

The impact of the US financial crisis was immediate and devastating, and both countries are still living with its consequences.

That is why Donald Trump’s election as US president, and his stated policy goals regarding China, are fraught with danger.

The mainstream economics professionals have retired to their fainting couches as a result of the protectionist noises Trump made on the campaign trail and since.

They were joined by the nation’s diplomats and old China hands, who had a collective stroke when the president-elect accepted a congratulatory phone call on December 2 from the president of Taiwan, Tsai Ing-wen, and then tweeted about it.

China says Taiwan is a renegade province that will someday return to Beijing’s mother ship, and longstanding diplomatic protocol between Washington and the PRC has precluded any contact between Taiwan’s leader and the US’s. (The last time a US president spoke to his counterpart in Taipei was 1979.)

Two days later, Trump again signalled to Beijing that it wouldn’t be business as usual when he took office. He tweeted that China never “asked us if it was ok” to “devalue” its currency or place tariffs on US exports, or to “build a massive military complex in the South China Sea” (a subject he had said little about during the campaign).

Again over the weekend, Trump said the US did not have to stick to its long-held stance that Taiwan is part of “one China”. His comments, on the Fox News Sunday TV show, questioned nearly four decades of US policy.

China reacted angrily. China’s foreign ministry said co-operation was “out of the question” if Washington could not recognise Beijing’s core interest in Taiwan, indicating that it would reject any effort by Trump to use the issue as a bargaining chip in a long list of commercial and security problems facing the two countries.

Beijing — and the rest of us — had better accept that this appears to be the real Donald when it comes to China policy, particularly on trade.

During the campaign, he called for a 45% tariff on Chinese exports and a 35% bill on any goods exported back to the US by American companies that send jobs offshore.

He repeatedly bashed China for “stealing” US jobs. He has, since the election, nominated as his commerce secretary businessman and investor Wilbur Ross, who, in his public statements, has indicated that he, like Trump, views trade as a zero-sum game: If you’re running a trade deficit, you are, as Trump might put it, a loser, and if you’re running a surplus, which China has for years, you’re winning big.

Further, one of the president-elect’s ‘brains’ on trade (though it’s not clear if he’ll have a job in the administration) is Peter Navarro, an academic whose two most recent books on China are titled Death by China and The Coming China Wars.

Putting that aside, Trump loves the place.

The economic relationship between the US and China is complicated and ill-served by shorthand versions of the current trade debate: ‘Slap a 45% tariff on ’em and all’s well’ versus ‘Cue the references to the Smoot-Hawley tariff, here comes the next Great Depression’.

It’s also remarkable the degree to which mainstream, free-trade economists and their fans in both politics and punditry get wrong basic things about the trade and economic relationship.

That’s why the conventional wisdom about a US-China trade war — that it would inevitably blow up in the US’s face — is not necessarily correct.

It’s widely assumed, for example, that a country running an account surplus will always be in a position of strength relative to a deficit country, when trade friction intensifies. But this is not borne out by facts.

Michael Pettis, a professor of finance at Beijing’s Tsinghua University — and one of the most clear-eyed observers of China’s economy and trade relationships — says: “The historical precedents are pretty clear that, during times of trade and currency war, it is the surplus countries that are most vulnerable.”

Consider one of the prevailing myths about why it’s foolhardy for Trump to even think about a trade war with China: Beijing owns more than $1tn of US debt, and has, over the last decade, been the biggest buyer at US Treasury auctions.

Donald Trump dampens US - Chinese relations

Hillary Clinton, the smart, seasoned diplomat, once said that picking a fight with China was too risky, because Beijing is “our banker”. The supposition here is that, should the US slap tariffs on Chinese goods, the Chinese central bank would dump its Treasury bills, driving up interest rates in the US, and punish the impudent ‘laowei’, or foreigner.

The only problem with that theory is that it’s wrong. Beijing doesn’t buy US debt — or anyone else’s, for that matter — either as a favour or to attain leverage in anticipation of a trade war (or worse).

The Chinese buy it because they try to peg their currency, the renminbi, at a relatively fixed rate to the US dollar, in order (among other reasons) to run domestic employment-producing trade surpluses. (If Beijing recycled its surpluses into its domestic bond market rather than the US’s, the value of the renminbi would increase relative to the dollar at a faster rate than China’s central bank has been comfortable with over the last decade. By selling dollar-denominated debt, in other words, China would be shooting itself in the wallet.)

Should the US start a traditional trade conflict — and based upon Trump’s rhetoric, that seems to be his plan — the risks for the US are more obvious and straightforward.

Across-the-board tariffs on Chinese-made goods (even those, presumably, made there by American companies and shipped back to the US) would bring almost certain retaliation against US products sold in China.

This is why, at a ‘watch party’ on election day (Wednesday morning China time), the mood at the American Chamber of Commerce in Shanghai turned “funeral”, said one participant, as it became clear Trump was going to win.

The US might not sell nearly as much in China as China sells in the US, but there are lots of fat targets for Beijing. In an editorial, the Global Times, a vituperatively nationalist newspaper in China, has already said, in effect: ‘Hey, Apple, nice little iPhone business you’ve got here in China. Be a shame if anything happened to it.’

A minority of economists — Pettis is one — say it’s possible for the US to get tougher on trade in a way that would benefit US workers, without triggering a trade war.

They argue that a trade policy that isn’t implemented “disruptively”, as Pettis puts it, “through a series of hasty and clumsy interventions [could benefit] US manufacturers and their workers” even more than it harms the rest of the country through higher import prices.

Pettis and like-minded economists are calling for the use of a stiletto in trade, but Trump seems more inclined to use a blunderbuss. Even some of the president-elect’s supporters are a little nervous about his campaign rhetoric.

China’s initial surge to manufacturing prominence came in industries such as shoes, textiles, luggage, and furniture — industries that had already migrated from the US (to South Korea, Taiwan, the Philippines).

There is no trade policy that will bring back those industries. Thus, an across-the-board, 45% tariff against Chinese goods “probably doesn’t make a whole lot of sense”, says Alan Tonelson, a longtime trade hawk who did a research project for Team Trump during the campaign.

Such a tariff would be the ham-handed intervention that Pettis and others warn against. It would do all the bad things conventional economists say protectionism does: It would harm the most vulnerable, low-income Americans, who spend a bigger percentage of their budgets on clothes, shoes, and furniture than do more affluent consumers, while doing nothing to help US employment or wage growth. It would also trigger Chinese retaliation, and potentially a ruinous trade war.

Trump’s supporters confidently play down the notion that China would respond in kind to any moves to restrict their exports.

Even though Beijing’s trade surplus now represents less than 3% of its overall economy — down from nearly 10% in 2007 — there is little chance, Tonelson and others say, that Beijing would jump into a full trade war with Washington.

If Trump believes this, Americans should be worried, because it’s a serious misreading of the Chinese government, and seems willfully ignorant of that most basic Asian concept: Face.

“The notion that Beijing wouldn’t retaliate, and retaliate strongly, is just laughable,” says a US diplomat speaking anonymously as they were not authorised to speak publicly on trade issues. “In order to retain any self-respect [at home], they’d have to respond.”

And if that happened, the possibility of a ruinous trade war — ruinous for both parties — would be very real.

Trump, of course, fancies himself the ultimate dealmaker, and it could well be that his “45% tariff” rhetoric is merely his opening bid; that he will sit down with president Xi Jinping, say during a two-day summit in California, as outgoing US president Barack Obama did in 2015, and figure out a way to ease tensions in what is undeniably a worsening economic relationship.

But that would require a detailed discussion — and knowledge — not just of where China is now, but of where it’s going. For Trump, that means making a critical choice: Does he base his policy on punishing China for the very real economic damage its trade in the US has done (as outlined by a paper titled ‘The China Shock,’ published at the beginning of this year by the National Bureau of Economic Research)?

Or does he focus on where Beijing has explicitly said it wants to go? One of the myths that trade hawks seem to believe about China is that its government can’t be trusted; that it won’t live up to trade agreements, and that it’s real economic strategy is a well-hidden secret.

Since its historic economic opening in 1978, this has rarely, if ever, been the case. That China would initially use its low-cost labour to succeed in export markets was obvious. So, too, was its more recently stated desire to diversify its economy away from export dependence. Now, Beijing is again making its economic desires transparently plain.

Workers at the Huajian shoe factory in Dongguan in south China’s Guangdong province. Donald Trump’s plan to raise tariffs on any goods imported from China will hit poor and economically unstable Americans hardest. Picture: Greg Baker/AFP/Getty
Workers at the Huajian shoe factory in Dongguan in south China’s Guangdong province. Donald Trump’s plan to raise tariffs on any goods imported from China will hit poor and economically unstable Americans hardest. Picture: Greg Baker/AFP/Getty

Consider ‘Made in China 2025,’ a document issued in 2015 by the State Council, Beijing’s chief policymaking body. Among its chief goals: Advancing Chinese manufacturing prowess throughout the process, and not just in innovation.

The document sets out clear and specific measures for innovation, quality, intelligent manufacturing, and green production, with benchmarks identified for 2013 and 2015, and goals set for 2020 and 2025.

“This is where China is headed,” says James McGregor, the Shanghai-based greater China CEO for APCO Worldwide, a consulting firm.

“The talk about 45% tariffs should be irrelevant. The United States needs to figure out how to respond to where China is going.”

That’s a lot more complicated than just applying an across-the-board tariff and declaring victory.

Trump and his trade team would do well to sit down with the heads of American multinationals in China and hear first-hand how the landscape is changing for them (it’s not getting better) and how the US government might respond.

Many American manufacturing companies, for example, have agreed to bring top-flight technology to China — if not necessarily the crown jewels — in order to be allowed to invest directly in that market.

Whatever the wisdom of that may have been 10 or 20 years ago, it now seems questionable, if you consider that Beijing’s goal is to dominate virtually all phases of manufacturing in less than a decade.

The ‘Made in China 2025’ plan can be read as a ‘go it alone’ strategy for Beijing; it’s, in effect, saying: “Thank you very much for all of your foreign direct investment over the last 20 years, we’ll be OK from here on — and, by the way, we’re going to eat your lunch.”

What might the US do in response? Dan DiMicco, the former CEO of Nucor Steel, who’s in charge of Trump’s transition for the United States Trade Representative’s office (and whom many people in Trump world believe should get the job himself), argues that US multinationals have been fearful of upsetting the Chinese government because they’ve been “understandably fearful of retaliation”.

But, now, if “China is going to undermine the investments Americans make and kick us out as soon as it can”, the Fortune 500 crowd needs to let the US government reciprocate: Look with a very sceptical eye at any Chinese direct investment in the US by a state-owned company, and make acquisition of US high-technology companies off-limits, something the Obama administration has already been doing. (In the summer of 2015, according to sources in both Beijing and Washington, the administration quietly made it plain that a Chinese company’s interest in Micron Technology, a Silicon Valley producer of microchips, was not appreciated.)

In other words, Chinese companies are aggressively trying to set up shop abroad (Beijing calls it the “going out” policy), and the US should make that a difficult proposition, if American companies are treated unfairly in China.

Calibrating an effective response should preoccupy the trade warriors in Trump’s administration. American, Japanese, German, and South Korean companies are still the global pacesetters in manufacturing and services, and China’s goal of surpassing all of them by 2025 — while perhaps overly optimistic — should not be dismissed as fanciful government propaganda.

“They’re dead serious about it,” says APCO’s McGregor. Making sure US companies maintain their competitive edge should be the focus of US trade policy. And you can’t do that, nearly all agree, by retreating into a protectionist shell.

That, ironically, was one of the reasons Obama pushed for the Trans- Pacific Partnership. Whatever its flaws, it was an ambitious trade agreement, negotiated with our allies, that excluded Beijing.

Together, Trump and Clinton killed TPP during the presidential election campaign, by bashing it. Now, Beijing has moved in with its own Asia-Pacific free-trade proposal, and, not surprisingly, countries from Australia to Japan to South Korea — all of which wanted the US-led TPP — are listening.

Is an Asian trading bloc dominated by China going to be better or worse for the US than the TPP would have been? Do you have to ask?

Trump was not wrong to campaign on the issue of trade. It resonated with a lot of economically insecure voters.

The problem is that his solutions to America’s trade problems are worse than the problems they’re supposed to fix. They could produce the same kind of pain on both sides of the Pacific that were felt in the wake of the 2008 financial crisis.

With his campaign over and won, Donald Trump now needs to get smart on trade. The question is: can he?


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